Felix Salmon

When banks have no reputation left to lose

Felix Salmon
Apr 21, 2009 22:09 UTC

The government wants Chrysler’s bank lenders to take a steep 85% haircut on their debt. The banks have now come back with an aggressive counteroffer, saying they will accept no more than a 35% haircut, and even then they want Fiat to put new money into Chrysler and they want a 40% equity stake for themselves to boot.

It doesn’t make a lot of sense that the banks, which are so dependent on Treasury, should be playing such hardball. But it turns out that it’s not the banks who are being particularly tough here, so much as the hedge funds holding bank debt:

The larger lenders were pushing for a counteroffer that was closer to the original government proposal than smaller lenders, such as hedge funds, were willing to agree to, said these people.

This conflicting view is likely due to several things, such as the fact the larger banks paid full price for billions of Chrysler bank debt, while smaller holders bought theirs at a steep discount and would likely make a tidy profit even in a quick liquidation of Chrysler, said people involved in the talks.

“Not everyone was on the same page. The big-bank view was ‘Hey guys, the offer back can’t be outrageous. This is the government,’” said one of these people. “There were others, smaller lenders, who wanted to be a lot more aggressive.”

I had to read this twice before I understood it: the big lenders who bought the debt at par were the ones pushing for a larger haircut, and therefore larger losses. Meanwhile, the small lenders who bought the debt at a discount and who are likely to make money whatever happens (thanks largely to the fact that the government continues to throw money at the automakers, in the face of recalcitrance from Detroit itself) are the ones who are trying to squeeze every last penny out of Chrysler: they couldn’t be conforming more to hedge-fund stereotype if they tried.

There’s a broader subtext, though, I think, to this counteroffer, which comes from the biggest names in US banking: JP Morgan, Citigroup, Goldman Sachs, and Morgan Stanley between them hold $4.3 billion of the $6.9 billion in debt, and are ultimately calling the shots. They’re saying that they’re perfectly happy to see Chrysler descend into a chaotic and destructive liquidation, because they’ll still end up with more money that way than they would if they accepted the government’s offer.

I daresay they’re narrowly right on that front, since the government’s injection of TARP funds into the automakers is a done deal and the banks would essentially be taking a large part of that money for themselves, rather than putting it towards supporting the Detroit car industry as a going concern.

From a public relations perspective, however, gratuitously driving a company as storied and economically important as Chrysler into bankruptcy is generally not the kind of thing that any bank wants to do. Unless, that is, banks in general have already hit the zero bound in terms of reputation. Call it the Ticketmaster strategy: you can do anything you like once everybody hates you.

This is what happens in a world of class warfare: the banks get demonized and hated on so much (and justifiably so, much of the time) that they no longer care about things like whether or not they’re driving the final stake into the heart of the Midwest’s manufacturing economy. Which might not be a reason to be nicer to them, but at least it might be a useful tactical consideration to bear in mind. Since they certainly seem to be feeling that they have very little to lose any more.


Hi Felix,
Here’s my insight: the average American is way more worked up about the possibility of fellow citizens getting something “extra” (unfair) from the government than they are about the probability of corporations continuing to suck down massive subsidies, grants and loans at our expense.

It’s perverse, but that’s what I see (it relates back to your whole class warfare meme nicely).

Banks see that there is no solidarity–no cohesive groups in America anymore: no unions, no party affiliations, just fragmentary groupings that dissolve and reform in seemingly random and politically ineffective blobs.

In short, yes, they know they are unpopular, but there is no counterweight to them in Washington or on Main Street, so they can pretty much do what they want.

Want evidence? Go here

http://www.ipetitions.com/petition/Bailo utAccountability/index.html

to read an online petition demanding that people who get “bailed out” to save them from foreclosure should preform community service as penance. Madame DeFarge could not express her class vitriol any better (and I also love the idea of people “anonymously” signing a petition!).

TARP datapoint of the day

Felix Salmon
Apr 21, 2009 19:15 UTC

The SIGTARP’s quarterly report to Congress (that’s Neil Barofsky, for those keeping track at home) runs to 250 densely-written pages. The news coverage is concentrating, rightly, on the fact that Barofsky is already investigating no fewer than 20 fraud cases associated with TARP funds, and also the rather alarming fact that PPIP fund managers might actually be forced to accept compensation caps after all. (If that does happen, you can be sure that Pimco, BlackRock, and the rest will immediately pull out of the scheme, leaving it doomed to failure.)

But there’s lots more where that came from. Not only is Barofsky worried about PPIP participants gaming the system, he’s also worried that the whole thing could easily become a front for money launderers:

Because of the significant leveraging available and the inherent imprimatur of legitimacy associated with PPIP and TALF, these programs present an ideal opportunity to money-laundering organizations. If a criminal organization can successfully invest $10 million of illicit proceeds into a PPIF, not only does the organiza- tion enjoy the possibility of profi ting through the Government-backed leverage, but any eventual distributions from the PPIF are successfully laundered because they appear to be PPIF investment gains rather than drug, prostitution, or illegal gambling proceeds.

The good news is that Congress has people like Barofsky and Elizabeth Warren’s Congressional Oversight Panel staffed up and keeping a close eye on Treasury’s bright ideas. The bad news is that it’s far from clear that Treasury has either the staffing or the inclination to pay much attention, let alone to implement their recommendations. Maybe once Treasury’s political appointeees are in place it will be a bit more helpfully responsive to (and grateful for) these extremely good reports.


Amazingly, congress seems to be the only part of our government displaying any sense of responsibility. With the Feds and Treasury handing out free money hand of fist, congress has used its powers to impose compensation limits as a test to see if the companies receiving the payouts are as desperate as they claim. Congress called the bankers bluff. And since the compensation limits were put in place, no one seems to think their company is in the dire straits they claimed just a few months ago.

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How to avoid a housing bubble, state regulation edition

Felix Salmon
Apr 21, 2009 15:57 UTC

Which nanny state:

  • Banned its mortgage lenders from imposing prepayment penalties;
  • Banned balloon repayments;
  • Banned negative amortization mortgages;
  • Banned loans based only on collateral value without regard to the borrower’s ability to repay the loan;
  • Banned lenders from charging for services the borrower didn’t receive;

–and thereby avoided the worst effects of the housing bubble?

Mike at Rortybomb has the answer, which might surprise you.


Bingo! Property taxes were the reason I looked into Texas investment properties but never bought. In fact, I never bought anywhere since California and Texas were my only two options due to management availability. Neither made sense from an investment point of view. By the way, I’m buying in California now. High property tax rates are incredibly destructive of real estate value. A person with money is going to look around and purchase where he can get the best rate of return. Taxes are expenses that shrink the net income a property can produce, thus the sales price of the property must be reduced to attract a buyer.

Yeah, a lot of people just aren’t used to thinking from an investment point of view, especially journalists who don’t know anything other than how to write, and government types who have no real world experience outside of politics. That’s why there are so many stupid policies that simply won’t work like rent control. Rent control discourages investment and new construction–that will increase rents in the long run due to less supply of housing.

Can Geithner stop banks withdrawing from TARP?

Felix Salmon
Apr 21, 2009 12:30 UTC

Tim Geithner is sensibly laying out pretty strict criteria for when he will allow banks such as Goldman Sachs and JP Morgan to repay their TARP money. It’s not enough that the banks themselves be healthy, he tells the WSJ: he will also consider “the overall health of the financial system and the flow of credit”.

I’m happy about this: the healthier banks were slated for inclusion in the TARP program for a reason, and that reason hasn’t gone away. What’s more, banks like Goldman and JP Morgan seem to think that repaying TARP funds will give them an artificial advantage over the rest of the big players, especially when it comes to things like executive compensation. Is there any reason for the government to let them have that advantage, when their too-big-to-fail status gives them an automatic “Geithner put” in the event they blow up?

Still, relations between Treasury and Wall Street are not healthy right now, and Nemo has been checking out Division B, Title VII, Sec. 7001, SEC 111(g) of the American Recovery and Reinvestment Act of 2009 (scroll down a bit here to find it):

Subject to consultation with the appropriate Federal banking agency (as that term is defined in section 3 of the Federal Deposit Insurance Act), if any, the Secretary shall permit a TARP recipient to repay any assistance previously provided under the TARP to such financial institution, without regard to whether the financial institution has replaced such funds from any other source or to any waiting period, and when such assistance is repaid, the Secretary shall liquidate warrants associated with such assistance at the current market price.

That’s pretty unambiguous: Goldman and JP Morgan can pull out unilaterally if they’re so inclined — and if they’re foolish enough to want to seriously annoy the government.

In normal times, no bank would be remotely inclined to do something which the Treasury secretary has quite explicitly told them he doesn’t want them to do. But these of course are not normal times, and this is going to be an interesting test of Geithner’s control over a fractious Wall Street. If he lets Goldman and JP Morgan withdraw early from the TARP any time soon, he’s going to be seen as very weak for the foreseeable future.


this is a test

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Monday links look at banks’ books

Felix Salmon
Apr 20, 2009 23:03 UTC

Citi’s Earnings: Even Cittier Than You Think: Dear John Thain gets into the weeds, and doesn’t like what he sees.

IFRS vs US-GAAP: European Banks Leverage Overstated: One (not the only) reason why European bank-leverage numbers are so scary. I’m not happy about the chart, though, which doesn’t seem to be to scale.

“I Love Charts”: From Sid the Science Kid. Adorable.

Enjoy Banking!


Agree with ax above. Love you stuff Felix, but ditch the new links headline.

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Do CDSs cause more bankruptcies?

Felix Salmon
Apr 20, 2009 21:35 UTC

Charles Davi has spent 1500 words replying in great detail to my blog entry about whether the CDS market has a deleterious effect on bankruptcy negotiations. He’s basically correct, as far as he goes, and indeed I did mix up an Event of Default with a Credit Event — my bad. But still I think he misses the bigger picture.

The problem, at heart, is this: debt negotiations are hard, arduous things. Nobody likes going through them — especially not big institutional bondholders, who can suddenly find themselves with 1% of their portfolio taking up 50% of their time. It’s something everybody wants to avoid if possible, especially since bondholders who engage in negotiations generally have to constrain themselves from trading in or out of the debt in question.

And so, at the margin, anything which makes it easier to ignore bond-restructuring negotiations is going to be jumped at by the creditors of any company. Given the choice between buying credit protection and entering into negotiations, most bondholders will happily buy the protection, even if it costs them a little bit more money.

I’m not for a minute positing the existence of protection buyers who actively seek to derail bond renegotiations so as to maximize the payout on their derivatives. Instead, I’m just saying that it becomes much harder for borrowers to renegotiate their bonds when the bondholders don’t particularly care what happens either way, because they’ve gone and bought themselves credit protection.

The problem with the originate-to-distribute model of mortgage lending was that the people who were meant to underwrite the loans couldn’t be bothered to, because they had no intention of holding on to them. Call it sheer laziness, if you like, if you don’t want to ascribe any malign intent, but the fact is that there’s an opportunity cost to getting dragged into long and boring procedures, and often a quick financial deal is much easier and cheaper than doing hundreds of hours of forensic and accounting homework.

I fear that the growth of the CDS market has made it altogether too easy for bond investors to simply rid themselves of troublesome considerations pertaining to companies in distress. Selling distressed bonds outright is extremely unpleasant; buying enough protection to limit your downside, by contrast, is simply prudent. Once you’ve done that, who can blame you for not getting bogged down in negotiations?

It’s far too early to say whether we’re going to see more bankruptcies as a result of this phenomenon, or even whether that’s necessarily a bad thing. But I do think it’s a legitimate concern.


Annubis: “Those who fail to learn the mistakes of the past are doomed to repeat them”, Victor Hugo.

Good notion, wrong author – who is George Santayana.

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Pulitzer datapoint of the day

Felix Salmon
Apr 20, 2009 20:24 UTC

Number of 2009 Pulitzers awarded for financial journalism: 0.


The problem with this poll is that the choices are not mutually exclusive…one could validly argue that all four are simultaneously true…I would, however, agree with Equity Private.

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The no-news market move

Felix Salmon
Apr 20, 2009 19:35 UTC

It’s a bad day in the stock market, with the Dow down more than 3%. But “early March levels”? No. In early March, the Dow was a good thousand points lower than it is now, and the XLF index of financial stocks, which is trading at just over $10 today, was somewhere below $7. So let’s keep things in perspective, here: we’ve had a big run-up in stocks over the past few weeks, and it’s only natural that they will pull back occasionally.


Even weirder is the idea that some radio-station nutjob in New Jersey actually moved the market with his report that the bank stress tests were finished, and looked “very bad”. Says Bloomberg:

The Financial Select Sector SPDR Fund, an exchange-traded fund tracking banks, brokerages and insurers, fell to $10.62 from $10.75 in six minutes after FlyOnTheWall.com cited Turner’s blog post at 8:14 a.m. in New York. At 8:30 a.m., FlyOnTheWall advised readers to disregard the earlier story.

What Bloomberg doesn’t say is that the fund in question wasn’t trading between 8:14am and 8:20am: the New York markets are closed then, and weren’t going to open for more than an hour. Pre-market trading is always thin and volatile, and prices can move for any or no reason. Besides, when markets did open, an hour after the news emerged that the blog entry was bullshit, XLF had fallen even further, to $10.59, and it’s been tumbling for most of the rest of the day as well. So it’s a bit much to ascribe any move to this one story, especially when, as Ryan Avent points out, the author of the blog claims to have found stress-test results for HSBC, a bank which isn’t even being tested.

What we’re seeing here is the result of a very common bias: if a stock or an index moves, every journalist’s first instinct is to look for some kind of news which might have moved it. If there’s no obvious news story which might be responsible, a lot of journalists will then start citing non-obvious news stories instead, or even news stories which, by rights, should have moved the market in the opposite direction.

The fact is, however, that especially in these days of extremely high volatility, most stock moves don’t have a reason, especially not a news-based one, and that it’s profoundly silly to look for one — nearly as silly as it is to confuse a one-day fall in indices with a return to multi-decade real lows.

And the lesson of all this? Don’t believe what you read on blogs — but don’t believe what you read in more mainstream journalistic outlets, either. They’re all prone to hyperbole, and the best thing you can do most of the time is simply ignore all of it, and go for a nice walk instead.


Gee, Felix. If I’m not supposed to believe what I read on blogs, why am I reading yours? :)

Vulture fund datapoint of the day

Felix Salmon
Apr 20, 2009 18:25 UTC

Liberia, with the aid of the World Bank, has been negotiating with vulture funds holding $1.2 billion of its debt. You know what vulture funds are, right? They’re evil hedge-fund types who buy up debt at pennies on the dollar, and then sue for repayment in full, with interest and penalties and everything.

Just look at the deal they drove in this case! Liberia, one of the poorest countries in the world, is going to have to pay them, er, nothing at all. The World Bank is kicking in $19 million, a few rich countries are matching that sum, and the vultures are walking away with a not-very-princely-at-all $38 million, or just 3 cents on the dollar. Which probably barely covers their legal fees, let alone the amount they paid for the debt in the first place.

Meanwhile, Ecuador has come out with its own offer to bondholders: 30 cents on the dollar, which is either a “minimum price” (Bloomberg) or else just a starting price which the finance minister expects to fall in a “modified Dutch auction” (Reuters). Dow Jones says it’s a modified Dutch auction with a minimum price of 30 cents on the dollar; in any case, what’s clear is that no one is going to pay much attention to the technicalities until the current government is re-elected next week and all the electoral noise is in the past.

There are many more questions than answers right now on the Ecuador front. For instance, if the bondholders do accept the offer, where will the money come from? How will the auction work? What’s the minimum number of bondholder acceptances needed for the offer to go ahead? If the offer fails, will the Ecuadoreans continue making the coupon payments on their 2015 bonds in full? And since the secondary-market price of the defaulted bonds seems to refuse to fall below the 30-cent level, why would anybody take the government’s offer rather than just sell in the secondary market?

But still, the Liberian precedent will be sobering for anybody thinking about a vulture-like holdout strategy. Sometimes, holding out can pay handsomely: after the last distressed Ecuadorean bond exchange, the small number of holdouts was paid off in full. But as the Liberian example shows, it’s a very high-risk gamble, and it can end up in utter failure.